IRC Deductibility of Construction Contract Costs – CAAD Arbitration 297/2013-T

ARBITRAL DECISION

CAAD: Tax Arbitration

Case no. 297/2013 – T

Subject: IRC – Construction contract; Deductibility of expenses.

The arbitrators Dr. Jorge Manuel Lopes de Sousa (arbitrator-president), Dr. José Alberto Pinheiro Pinto and Professor Miguel Patrício, appointed by the Deontological Council of the Administrative Arbitration Centre to form the Arbitral Court, constituted on 06-03-2014, agree as follows:

1. Report

Society A, S.A., NIPC ..., submitted a request for constitution of the collective arbitral tribunal, in accordance with the joint provisions of articles 2nd and 10th of Decree-Law no. 10/2011, of January 20 (Legal Regime of Arbitration in Tax Matters, hereinafter referred to only as RJAT), in which the TAX AND CUSTOMS AUTHORITY is the Respondent.

The Claimant seeks to have declared illegal the additional assessment of IRC and compensatory interest no. 2013 ..., relating to the year 2009, dated 15-07-2013, in the amount of € 62,540.00.

The request for constitution of the arbitral tribunal was accepted by the President of CAAD and automatically notified to the Tax and Customs Authority on 19-12-2013.

In accordance with the provisions of paragraph a) of item 2 of article 6th and paragraph b) of item 1 of article 11th of RJAT, the Deontological Council appointed as arbitrators of the collective arbitral tribunal Councillor Jorge Lopes de Sousa, Professor Miguel Patrício and Dr. José Alberto Pinheiro Pinto, who communicated their acceptance of the appointment within the applicable deadline.

On 19-02-2014, the parties were duly notified of this appointment, and did not manifest any intention to refuse the appointment of the arbitrators, in accordance with the combined provisions of article 11th item 1 paragraphs a) and b) of RJAT and articles 6th and 7th of the Deontological Code.

Thus, in accordance with the provision in paragraph c) of item 1 of article 11th of RJAT, the collective arbitral tribunal was constituted on 06-03-2014.

The Tax and Customs Authority submitted a reply, arguing for the dismissal of the arbitral request.

At the meeting provided for in article 18th of RJAT, held on 30-04-2014, it was agreed that witness evidence should be produced, which was produced on 22-05-2014.

At that meeting, the Parties were notified to submit successive written submissions and the date of 02-07-2014 was set for the pronouncement of the arbitral decision.

The Claimant submitted submissions concluding as follows:

A. The works valued at € 3,850,000, to which € 10,000 owed to the works management entity should be added (cfr. request, page 6), which are herein considered and whose cost was entirely borne by the claimant, represented, from an economic and accounting perspective, financing carried out by the claimant to B which aimed to ensure that this company could install and operate a health club that constituted an anchor store of the commercial centre C;

B. This financing was given concrete form in the execution of a "turnkey" construction contract between B and D (managing company which later merged into the claimant) through which D/Claimant delivered into the hands of B the definition of all fundamental aspects of the corresponding work, namely:

a. Responsibility for the architecture and specialties of the works and supervision of construction (cfr. First clause);

b. Obtaining building and use licenses;

c. Responsibility for expenses with the preparation of studies, projects and work necessary for the construction of the Health Club;

d. Subrogation to D/Claimant in all obligations assumed relating to the construction and licensing (including chamber fees)

C. That is, it is abundantly clear that this was not a normal construction contract in which the owner of the work is responsible for the conduct and responsibility of the generality of the aspects highlighted in the previous conclusion, but a contract in which, with the exception of the financial expenditure on the work, who assumed the true position of "owner of the work" was B, being responsible for the conception, contracting, direction, and licensing of that same work, from start to finish;

D. Clearly, the Claimant assumed a position of financer or subsidiser, aiming thereby to ensure the installation of a unit with a brand and position in the market recognized that would enhance the attractiveness of the shopping centre itself and anchor its users.

E. Moreover: this was work inextricably linked to the health club use contract, which, in parallel, was executed between the same two entities, being that use undeniably intuitu personae, because intended specifically for use for a gymnasium E.

F. The meaning and scope of this connection is very easily grasped if we look at no. 4 of clause 10th of this latter contract: it is provided that the non-opening of the health club within the timeframe determined there would give the right, among others, to compensation for all values paid by the Claimant to B within the scope of the construction contract that were found not directly employed in the construction or, having been employed therein, could not be reused because intrinsically linked to concept E.

G. Thus, all argumentation of the AT based on the strict character of "construction" of the said contract is lacking, namely when it says that, contrary to what was provided in that contract, in situations of "fit-out" of anchor stores versed in the said DSIRC Information the "installation works are decided by the tenants, these assuming responsibility for them (...)" (cfr. art. 45°, Reply);

H. We are in the presence, also here, of an anchor store whose works are decided by the tenant, although wholly subsidised by the Claimant and although – as with the other anchor stores – the works subsidised will revert to the Claimant.

I. It is, therefore, here, in line with what is maintained by Dr. João Rodrigues and by F, an expense that constitutes financing subject to annual depreciation, to whose annual projection in revenues (in account # 7240009) should correspond the concomitant specialization in expenses (in account # 6221010) for the period of duration of the underlying contract;

J. From a fiscal perspective, there is no doubt whatsoever about the indispensability of the same cost, beyond reporting to an expenditure effectively linked to the business purpose of the Claimant, the expense in question (rectius, its annual specialization) is direct and inseparably linked to the revenue corresponding to the portion of the minimum remuneration computed as depreciation of the works financed by the Claimant (cfr. art. 23°)

K. Now, even if this thesis were not agreed with, there is no way to deny that we would always be in the presence of a contribution for works or "fit-out" (in this case, almost total contribution, which excludes studies and projects, as we have seen), which must observe the treatment recommended by DSIRC in the Information and which is extensively described in arts. 34° to 40°.

L. In all situations analysed in that Information, the balance between costs and revenues, also from a fiscal perspective, must be ensured, either through the synchronous recognition of correlated costs and revenues, or through the absence of fiscal adjustments in cases where fit-out expenses and corresponding revenues only move balance sheet items.

M. Again in this respect, it is important to emphasise that the fact that it is provided in the use contract (cfr. cl. 3rd) that in case of unilateral renewal of the contract by B the rent could not be lower or higher than 10% of the amount of the remuneration in force at the date does not mean, in any way, that there was no contribution, but very probably that, not knowing the Claimant what the market conditions and valuation of the commercial centre would be at the end of 15 years, there had to be ensured that, in case of renewal that might be imposed on it, the remuneration guaranteed to be paid by B would be as high as possible;

N. The obstinacy in the sublimation of the importance of the supposed sale intention – and, to be fair, for the fiscal result that by virtue of it the AT insists on advocating – and for the consequent registration of the works in question in inventory accounts, is inversely proportional to the same attitude of the AT in face of the concept of "change of purpose of the asset", for IMI purposes, resulting from the shop use contracts; there is already a qualitative change that should mean the accounting transition from inventory to fixed assets;

O. Thus it is unmistakable the effect of this double conception on the same economic-accounting phenomenon, namely that of the maximization of fiscal income in IRC and in IMI.

P. And that concern of the AT does not stop here, for even if it were to be admitted what only makes sense for the benefit of theoretical discussion – that the expense relating to the works in question could only be recognized through depreciation, nor thus would there be grounds for any correction in favour of the Administration, but quite the contrary.

Q. In the case at hand, the recognition of the expenses in question as depreciations, could well lead to a fiscal recognition more accelerated than is now being done over 15 years, since the works in question relate to elements that were integrated into a fraction of the commercial building of C delivered in shell to B, this one, depreciable over a period of more than 15 years.

R. The elements in question will be, in their majority, classifiable in Groups 2, 3 and 5 of the generic Tables of DR 2/90 or, even if assigned to the building itself (as coatings) could be depreciated at a rate of 5% under the terms of Code 2025 of DR 2/90 (recreational services), and, therefore, depreciable in 20 years.

S. The Claimant does not have – by virtue of the entity supervising the works not having provided them and of the work in question having been executed under the direction of B, billed to it by the construction company, and being used by it –, the data relating to each element of the fixed asset, having only those data aggregated by various groups (see Document no. 7 which is attached and whose contents are given as wholly reproduced).

T. However, the Claimant simulated the rates of depreciation to which each of the elements of these groups of assets would be subject, if they were being depreciated having computed an overall weighted rate of 7.7%, higher than the rate of 6.66% implicit in the deferment over 15 years.

U. Now, for the AT the works in question that moved to "investment properties" should have been subject to the "depreciation rate practised by the taxpayer" of 2.5% (cfr. report, page 8, whose legal basis is completely unknown), and, therefore, be depreciated over 40 years, when to the type of tangible assets in question corresponds in DR 2/90 and in the regulation that succeeded it an average useful life of about 13 years.

V. In conclusion, and for everything that has been stated above, the act of additional IRC assessment here challenged cannot remain in the legal order as it proceeds from an erroneous interpretation of the legal presuppositions of the norms on which it was based, namely by advocating an adjustment to the accounting result not provided for in articles 17° et seq. of CIRC.

Whereby it is concluded, as in the initial request, asking for the declaration of voidability of the acts on which the pronouncement of this Court is requested, with all legal consequences.

The Tax and Customs Authority concluded its submissions by referring to the Reply it submitted, renewing the understanding that the claim formulated should be judged unfounded.

The Arbitral Court was duly constituted and is competent.

The parties possess legal personality and capacity and are parties with standing (arts. 4th and 10th, item 2, of the same regulation and art. 1st of Ordinance no. 112-A/2011, of March 22).

The proceedings do not suffer from nullities and no obstacle is perceived to the consideration of the merits of the case.

1. Findings of Fact

2.1. Proven Facts

The following facts are considered proven:

a) The Claimant A has as its object "the construction, urbanization and management of real estate; the purchase and sale of real estate for itself or for resale; promotion and exploitation of real estate" (certificate at fls. 19 of the digitalized Administrative File);

b) The commencement of business (of the Claimant) occurred on 22-12-2005 and, until the year 2008, inclusive, the company was taxed for the activity of construction of buildings (residential and non-residential) (Tax Inspection Report on page 44 of the digitalized Administrative File, whose content is given as reproduced);

c) From 2009 onwards, at least until the date when the inspection report was prepared, the main activity of the Claimant was real estate promotion (development of building projects) and the secondary activity was the purchase and sale of real estate goods (Tax Inspection Report on page 44 of the digitalized Administrative File, whose content is given as reproduced);

d) On 01-01-2008, the Claimant incorporated, by merger, the company "D, S.A.", an entity that until that moment exercised the management of the commercial centre "C" (hereinafter "C"), also acquired (on 28.12.2007) by the Claimant (Tax Inspection Report on page 49 of the digitalized Administrative File, whose content is given as reproduced);

e) The Claimant is engaged, among other activities, in the construction, promotion and exploitation of shopping centres, and, at the time of the facts, it was responsible for the promotion, construction and exploitation of C (Tax Inspection Report on page 49 of the digitalized Administrative File, whose content is given as reproduced);

f) Within this scope, it is up to it to recruit tenants for installation in the fractions that the centre has, in order to achieve the number of visitors and volume of business that will allow it to achieve its profit objectives;

g) For this purpose, there are the so-called anchor stores which, by their potential to attract public to the other stores and to the shopping centre in general, are indispensable for its success and which may justify an investment by the promoter itself in their installation;

h) Such was the case with the installation of a gymnasium "E" in C in 2007;

i) On 15-10-2007, a contract was executed between the company D – COMMERCIAL CENTRES MANAGEMENT, S.A. (which was later incorporated by merger into the Claimant), and the concessionaire of that gymnasium brand for Funchal, B – Unipessoal, Lda, the «Contract for Services Provision in the Scope of Construction and Delivery of Health Club in "Turnkey" Mode» a copy of which appears in document no. 3 attached to the initial petition, whose content is given as reproduced, in which it was agreed, in addition to much else, the following:

i. B undertakes to construct or have constructed by third parties under its responsibility a health club of the "E" brand, with approximately 1,369 m2;

ii. This construction would consist of the adaptation of the shell store already built in the commercial centre C to the specificities of the gymnasium that A intended to operate;

iii. The price of this construction would be €3,850,000.00, to be invoiced by B to the Claimant;

iv. The health club should be delivered fully completed.

j) On the same date 15-10-2007, D – COMMERCIAL CENTRES MANAGEMENT, S.A., B Funchal and G, SGPS, S.A., executed a «Contract for Use of Health Club In Shopping Centre», a copy of which appears in document no. 4 attached to the initial petition, whose content is given as reproduced, in which it came to be stipulated, in addition to much else, the following:

k) B Funchal would pay to the Claimant a periodic monthly rent for the use of the shop, during the period of 15 years from the beginning of the opening to the public of the Health Club, called "Minimum Remuneration", which comprised:

i. A first predetermined portion, with its monthly value of € 10.50, per square meter of area of the Health Club, estimated, at that date, at the monthly value of € 14,374.50, plus VAT;

ii. The second portion would be calculated after the completion of the adaptation of the Health Club, with its monthly value corresponding to the result of the multiplication of the value (without VAT) paid by the Claimant to B Funchal for the construction and delivery "turnkey", by the factor 0.07, divided by twelve, proceeding to round to the cent of the result, estimating the monthly value, at the date of the contract, at €22,458.33, plus VAT;

l) From an accounting perspective, the treatment given by the Claimant to what results from this contract for the 15-year period was as follows:

i. In a balance sheet account the claimant recognized the value of the service provision contract executed with A of €3,850,000.00, which corresponds to the 15-year credit it granted to the latter under the terms of that same contract (Tax Inspection Report, fls. 16);

ii. The value of the monthly invoicing of €22,458.33 corresponding to the financial pass-through to A, by the contesting party, of the monthly provision of that contract (Total Value x 0.07/12), was, every month, reflected in account # 7240009, an account of revenues (Tax Inspection Report, fls. 16);

iii. The cost of the construction contract was credited in account # 2741 – "Other accounts receivable" for the total value of €3,850,000.00 plus €10,000.00 owed to the works management entity (Tax Inspection Report, page 17);

iv. As a counterpart of this account, the amount of €21,444.44 was being debited as an expense in account # 6221010, by transfer from said account 27, in each one of the months of the years 2008 and 2009, which corresponds to €3,860,000.00/15 years/12 months (Tax Inspection Report, page 17).

m) On 21-12-2006, the Legal Substitute of the Director-General of Taxes manifested agreement with the content of information no. .../..., issued in Process IRC.../2006, E. G. / SAIR .../..., a copy of which constitutes document no. 5 attached to the initial petition, whose content is given as reproduced, in which the following conclusions are formulated:

In the case sub judice, the fiscal recognition of expenses borne by the entities owning the shopping centres with the installation of the so-called "anchor stores" depends on the existence or not of a clause in the contract imposing consideration to the tenant for the contribution to the installation expenses and the accounting treatment given to such contribution to expenses by the entities owning the shopping centres.

It should be noted that, in accordance with supplementary information from the Inspection Services, Installation expenses are always borne by the tenants, and these must register them as works on others' buildings.

When consideration is not imposed on tenants for the contribution to expenses incurred by the owners, it appears to be a situation similar to that of subsidies for investment, that is, everything happens as if the entities owning the shopping centres were giving a "subsidy" to the tenants to invest in the works, the expenses borne by the entities owning the shopping centres with those works not being able to be recognized as costs in the years in which they are incurred, but should be allocated to each year, in accordance with the number of years of the contract.

When consideration is imposed on the tenants, two hypotheses arise:

a) In the case in which the entity owning the shopping centre incurred the expenses as if it were financially supporting the burden on account of the tenants, those expenses should not go through cost accounts, but accounts of third parties, having no impact on the fiscal result.

b) In the case in which the entity owning the shopping centre incurred the expenses and registered them in its accounting with a view to obtaining future economic benefits, those expenses should be balanced with the future revenues associated with them, in the same proportion as the consideration actually received. Also in this case those who effectively bear the installation costs of the shop are the tenants installed there, although over time and in accordance with the amount of sales obtained. In these cases, the value of the contribution registered in costs and the value of the rent (additional percentage of sales) received as consideration of the tenants for that financial contribution originate a result of zero sum, having, in this way, no fiscal impact, just as in the previous hypothesis.

n) In compliance with service orders no. O... and O...., a general inspection action was carried out on the taxpayer now Claimant, covering the years 2009, 2010 and 2011.

o) In the Tax Inspection Report, whose content is given as reproduced, it is referred to, in addition to much else, the following:

«A.3.2.7. Fit-Outs – account 7240009

In accordance with what is described in the Annex to the Balance Sheet and Statement of Results, Fit-Outs correspond to the contribution of the taxpayer in the expenses incurred by some tenants in the adaptation of the shops, and may be reimbursable, in which case they are considered as including the Remuneration for the use of the shop.

Fit-Outs are recognized as deferred costs, being transferred to period expenses during the useful life of the lease contract.

However, it was found that regarding the customer "B Funchal" it is not a contribution to the works, but rather a provision of services (remuneration for the use of the shop).

Facts relating to the values registered in the accounting as Fit-Outs:

– On 2007-10-15, a service provision contract was executed between the taxpayer and "A, Unipessoal, Lda", NIPC ..., in which the latter undertakes, at the fixed global price of €3,850,000.00:

– to have constructed by third parties under its responsibility a health club of the "E" brand to be implemented in shop 118, with approximately 1,369 m2,

– to deliver to the taxpayer the completed health club;

– to arrange for the obtaining of the respective building and use licenses.

– On 2007-10-15 [that is, on the same date] a contract for use of a health club in a shopping centre was executed [between B and D], in which it is stipulated:

– a term of the right of use of 15 years (clause 3rd);

– for the use of the health club B will pay, in addition to the Minimum Remuneration, and in accordance with what is established in paragraph b) of point 1 of clause 5th, a monthly value corresponding to the result of:

– multiplication of the value (without VAT) paid for the construction of the health club by the factor 0.07, and divided by 12, estimating that the monthly value will be €22,458.33 (=3,850,000.00 x 0.07 / 12), to which VAT is added at the legal rate in force»

A.3.3. Supplies and External Services (FSE)

An analysis was made of the main sub-accounts of Supplies and External Services, as well as their supporting documents (through selection of the documents of greater value).

A.3.3.1. Values registered in the accounting:

[Table content - omitted for clarity]

A.3.3.2. FSE not accepted for fiscal purposes: Costs/Expenses recorded as related to Fit-Outs.

«In accordance with the facts exposed in point A.3.2.7 (…) it was found that:

– On 2007-10-15 a service provision contract was executed between the taxpayer and "A Funchal, Unipessoal, Lda" (…), in which the latter undertakes, at the fixed global price of €3,850,000.00:

– to have constructed by third parties under its responsibility a health club of the "E" brand to be implemented in shop 118, with approximately 1,369 m2,

– to deliver to the taxpayer the completed health club;

– to arrange for the obtaining of the respective building and use licenses.

– In the year 2008 the taxpayer carried out the construction of the health club, whose amount totalled €3,860,000.00, having registered the value in a sub-account of "2741 – Other accounts receivable", thus divided:

– €3,850,000.00: total invoiced by B relating to the construction

– €10,000.00: total invoiced by "H, S.A. (…), relating to works management.

– The taxpayer divided the total value of the construction, amounting to €3,860,000.00, over the term of the right of use of the health club by B (15 years), which corresponds to a monthly value of €21,444.44 (= €3,860,000.00 / 15 years / 12 months).

– Thus, it transferred from sub-accounts of "2741 – Other accounts receivable" to the account "6221010 – Other specialized works", the annual amount of €257,333.28 (= €21,444.44 x 12).

In conclusion, and in consonance with the corrections and conclusions made in the inspection action for the year 2008:

It is concluded that the contract executed between the taxpayer and B is a construction contract, as defined and regulated in article 1207º and following of the Civil Code (CC), the taxpayer being the owner of the work, even though it is the contractor who provides the materials, in accordance with the provisions of article 1212º of the CC.

The taxpayer recognized as an expense of the year the annual amount of €257,333.28, relating to the specialization of the years 2009 to 2011 of the cost of construction of the installations of a "health club".

Given that the taxpayer recorded the fraction in inventory in the year 2008, and in accordance with the valuation methodology of inventories described in the Official Accounting Plan (POC), that cost would be considered production cost, and consequently allocated to the fraction through the mechanism of inventory variation and thus would not affect the value of the result determined in the year.

Thus,

– the costs/expenses recognized in the years 2009 and 2010, in the annual amount of €257,333.28, are not accepted for fiscal purposes under article 23º of CIRC, since the fraction was recorded in inventories/stocks»;

p) In the year 2009, the real estate on which the costs/expenses were incurred that were not considered for fiscal purposes was recorded in the accounting as inventory;

q) Having been notified for the purpose of hearing regarding the corrections that were projected (cf. fls. 65 of PA), the taxpayer only presented elements/clarifications relating to points A.4.3 and A.4.4 of the inspection report (cf. fls. 77 et seq. of PA), whereby the Tax and Customs Authority understood that said correction was consolidated and the taxable profit declared in the year (€2,912,630.14) was corrected, setting the taxable matter at €3,171,268.30 (cf. fls. 115 of the Administrative File).

r) Based on that correction, the additional assessment no. 2013 ... and compensatory interest was made, dated 15/07/2013, in the amount of €62,540.00 (document no. 1 attached to the request for arbitral pronouncement, whose content is given as reproduced);

s) On 18-12-2013, the Claimant submitted the request for constitution of the arbitral tribunal that gave rise to the present proceedings.

2.2. Unproven Facts

There are no facts relevant to the consideration of the merits of the case that have not been proven.

2.3. Reasoning for the Proven Facts

The facts were given as proven based on the Tax Inspection Report and the submissions of the Parties, not being contested.

1. Legal Matters

3.1. Subject Matter of the Dispute

Although the Claimant, in formulating the request, makes reference to the «declaration of illegality of the assessments in question, relating to the years 2009 and 2010», it is manifest that the references to the year 2010 and to assessments, in the plural, are made by lapse, as the Claimant identified only in article 2nd of the request for arbitral pronouncement the assessment relating to the year 2009 and in article 5th of the same request for arbitral pronouncement, expressly and unequivocally, stated that «without prejudice to contesting other corrections in other forums, in the present proceedings, the claimant only contests the correction identified in point A.3.3, in the amount of €257,333.28 relating to the year 2009».

In the definition of the subject matter of the dispute it must be taken into account that the tax arbitral process, as an alternative means to the process of judicial challenge (item 2 of article 124th of Law no. 3-B/2010, of April 28), is, like this one, a procedural means of mere legality, in which the aim is to eliminate the effects produced by illegal acts, annulling them or declaring their nullity or non-existence [articles 2nd of RJAT and 99th and 124th of CPPT, applicable by force of the provision in article 29th, item 1, paragraph a), of that] ( [1] ).

For this reason, the acts of assessment that are the subject of requests for declaration of legality by arbitral courts operating in CAAD must be considered such as they were practiced, and the court cannot, when faced with the invocation of an illegal ground as support of the administrative decision, consider whether its action could be based on other grounds, of fact or of law, even if they are invoked afterwards by the Tax and Customs Authority in administrative or contentious challenge. ( [2] )

On the other hand, to the Courts of tax contentious proceedings it is only incumbent the function of settling the disputes arising from the practice of the act whose legality is contested, considering the questions raised by the parties whose knowledge is necessary for the consideration of that legality, to the strict extent of that necessity, as follows from the principle of limitation of acts, currently enunciated in generic form in article 130th of the Civil Procedure Code.

From this perspective, it is only important to ascertain whether the correction made by the Tax and Customs Authority to the taxable matter of the Claimant, for purely fiscal purposes, has legal support, and not to determine which form is the most adequate for accounting for the operations.

In the case at hand, the grounds for the correction made with respect to the year 2009 invoked in the Tax Inspection Report, which, as stated, are the only relevant ones to assess the legality of the act whose declaration of illegality is requested, are the following, referred to in paragraph o) of the findings of fact fixed:

– the contract executed between the taxpayer and A is a construction contract, as defined and regulated in article 1207º and following of the Civil Code (CC), the taxpayer being the owner of the work, even though it is the contractor who provides the materials, in accordance with the provisions of article 1212º of the CC;

– the Claimant recognized as an expense of the year the annual amount of €257,333.28, relating to the specialization of the year 2009 of the cost of construction of the installations of a "health club";

– given that the taxpayer recorded the fraction in inventory in the year 2008, and in accordance with the valuation methodology of inventories described in the Official Accounting Plan (POC), that cost would be considered production cost, and consequently allocated to the fraction through the mechanism of inventory variation and thus would not affect the value of the result determined in the year;

– the cost/expense recognized in the year 2009, in the amount of €257,333.28, is not accepted for fiscal purposes under article 23º of CIRC, since the fraction was recorded in inventories/stocks.

Thus, it is the legality of the additional IRC assessment relating to the year 2009, in light of this reasoning for the correction on which it was based, that is relevant to determine.

3.2. Consideration of the Merits of the Claimant's Claim

With respect to the determination of the taxable matter for IRC purposes, article 17th of CIRC (wording in force in 2009) provides the following:

Article 17th

Determination of Taxable Profit

1. The taxable profit of legal entities and other entities mentioned in paragraph a) of item 1 of article 3rd is constituted by the algebraic sum of the net result of the year and the positive and negative variations in patrimony verified in the same period and not reflected in that result, determined on the basis of accounting and eventually corrected in accordance with this Code.

(...)

1. In order to permit the determination referred to in item 1, accounting must:

a) Be organized in accordance with accounting standards and other legal provisions in force for the respective sector of activity, without prejudice to compliance with the provisions set out in this Code;

b) Reflect all operations carried out by the taxpayer and be organized so that the results of operations and variations in patrimony subject to the general regime of IRC can be clearly distinguished from those of others.

As can be seen from item 1 of this article 17th, not all rules necessary for the determination of the taxable matter of entities subject to IRC are established in tax law, generically referring to accounting standards, but with primacy of the norms of CIRC, as inferred from the final expression («...corrected in accordance with this Code»), essentially repeated in the final part of paragraph a) of item 3.

The justification for these relations between tax law and accounting is given in point 10 of the Preamble to CIRC, as follows:

«Since taxation is levied on the economic reality constituted by profit, it is natural that accounting, as an instrument of measurement and information of that reality, plays an essential role as support for the determination of taxable profit.

The relations between accounting and taxation are, however, a domain that has been marked by a certain controversy and where, therefore, different ways of conceiving these relations are possible. Excluding both absolute separation or total identification, a solution marked by realism continues to be favoured and which, in essence, consists in having the taxable profit reported back, originally, to the accounting result to which, extra-accounting, the corrections – positive or negative – listed in the law are introduced to take into account the objectives and conditions peculiar to taxation.»

In this line, it can be said that «accounting provides a conceptual basis for the operational definition of taxable profit, but, given the objectives and principles that frame taxation, there cannot be an identification between this and the accounting result because accounting also has objectives and principles that are its own and that must be safeguarded. In some countries an option is made even for a complete separation between these two quantities, but the tradition in which we are inserted is that of the partial dependence of taxable profit on the accounting result» ( [3] )

For its part, article 18th, item 1, of CIRC (in the wording in force in 2009), regarding the «Periodization of taxable profit» provides that «revenues and expenses, as well as other positive or negative components of taxable profit, are attributable to the period of taxation in which they are obtained or borne, regardless of their receipt or payment, in accordance with the economic periodization regime», which is usually designated as the principle of specialization of the years.

Paragraph b) of item 3 of this article 18th, regarding the provision of services of continued provision, establishes a special rule, in accordance with which «revenues relating to service provisions are in general considered carried out, and the corresponding expenses borne, on the date on which the service is completed, except where the services consist in the provision of more than one act or in a continued or successive provision, which are attributable proportionally to their execution».

As stated in the Tax Inspection Report – briefly "Report" –, "the main activity [of the Claimant] consists in the promotion, marketing, management, administration, maintenance, supervision and direct or indirect provision of services of real estate patrimony, of the shopping centre C, which was inaugurated on 2007-10-24".

In carrying out this activity, the Claimant recruits clients – tenants – with whom it executes contracts for use of the shops that make up the shopping centre. The revenues it collects – for which it is taxed in IRC – derive fundamentally from entrance rights paid to it by candidates to be tenants and from monthly remuneration for the use of the shops for a contractually defined period.

The shops were made available "in shell", being the responsibility of the tenants to carry out the works indispensable for them to be in conditions that permit the exercise of their respective business activities.

The choice of tenants did not depend on the candidates that might appear, instead obeying a planning aimed at attracting the final customers of the centre.

Within this scope, shops exist with greater importance than others, by their potential capabilities to attract, not only other tenants, but, mainly, final customers. Such shops are habitually designated as "anchor stores" and merit special attention from the entity managing the centre, namely, in the majority of situations, contribution to the costs borne with the installation and assembly works, and such contribution may take various forms.

With regard to the customer "B Funchal, Unipessoal, Lda." – briefly "B" –, which was an "anchor store" of great relevance within C, the Claimant executed on 15-10-2007 two contracts, manifestly linked to each other, in the following terms:

a) Contract for use of shop ("health club") in shopping centre (C) for a term of 15 years;

b) Contract for service provision, through which B undertook to have constructed by third parties, under its responsibility, a health club of the "E" brand, at the fixed global price of €3,850,000.00, value to which would be added the sum of €10,000.00 relating to works management.

In the contract for use of the shop, in addition to the minimum remuneration relating properly to the cession of space, there was provided for an additional payment, corresponding to the result of the multiplication of the value (without VAT) paid by the Claimant in the scope of the service provision contract (that is, €3,860,000.00) by the factor 0.07 and divided by 12, leading to a monthly value of €22,458.33.

Given the obvious link, even in time, between the two contracts, it is to be presumed that the factor 0.07 was found in the division of the value to be paid by 15, which is the number of years of validity of the shop use contract. In fact 1:15 = 0.06(6), which will have been rounded to 0.07.

In accounting terms, the Claimant recorded the cost of the works (€3,860,000.00) in account 2741 Other accounts receivable, so as to proceed to its allocation to the results of the 15 years of validity of the shop use contract, which led to a monthly value of €21,444.44.

Being thus, the value that was allocated to results of 2009, whose non-acceptance as an expense by the Respondent was at the basis of the contested assessment, totalled €257,333.28.

In the view of the Respondent, given the declared intention of resale manifested by the Claimant at the time of acquisition of the real estate in which is integrated the fraction leased to B, the cost of the work carried out in the fraction in question should have been registered in merchandise inventory and not recognized as an expense.

This understanding is not acceptable, in light of the aforesaid obvious link, in time and in content, between both contracts executed between the Claimant and B. The service provision contract cannot be regarded as if the shop use contract had not been executed on the same date and between the same contracting parties, and this latter objectively contradicts the correspondence to the reality of the intention of resale.

In fact, it is contrary to the existence of an intention of resale the fact that the shop use contract provides not only for a monthly payment for the use of space, but, in addition to this, for another payment, to extend for 15 years, which is calculated by the application of a factor (arising from the rounding of the quotient of the division by the number of years of validity of the shop use contract) to the total cost of the works.

Having the Claimant initially borne the cost of the works and establishing in the shop use contract that B would pay it, in addition to the normal price of the simple cession of space, a price practically equivalent to the cost of the works, everything happens, substantially, as if the Claimant had financed, without remuneration over the 15 years of validity of the shop use contract, the carrying out of those works charged to B, within the policy of favouring anchor stores in which this was framed.

In these terms, the Claimant acted correctly when, in harmony with the accounting principles of accrual or economic periodization (traditionally known as the principle of specialization of the years), substance over form and balance between costs and revenues or matching (in the designation of the Anglo-Saxons), opted to allocate to results the expense it bore with the carrying out of the adaptation works of the shop ceded to B.

Indeed, this attributability of revenues and expenses proportionally to the execution of the contract is in harmony with the rule of the final part of paragraph b) of item 3 of article 18th of CIRC.

Thus, the statement of results of the years of validity of the contract that it executed with this customer was being affected by three items, two positive (revenues) and one negative (expense), in the following terms:

Revenues:

a) Remuneration relating to the use of space;

b) Recovery of the cost borne with the adaptation works of the shop;

Expenses:

c) Allocation to results of the cost borne with the carrying out of the works.

It can be said that the true revenue arising from these contracts for the Claimant will have been that of the previous paragraph a), as the results from the items of paragraphs b) and c) practically compensate each other.

In fact, the monthly values of these items are as follows:

b) €3,850,000.00 x 0.07 : 12 = €22,458.33

c) €3,850,000.00 : 15 : 12 = €21,388.89

Consequently, were it not for the rounding introduced in the formula for calculating the sum to be received from the customer, the two items would have coincided.

It will be said that the works, at the end of the 15 years of validity of the contract, remain the property of the Claimant. The situation will not, however, be different from that of the other shops, in which the adaptation works are directly borne by the clients. Moreover, it is not guaranteed that such works, at that time, have economic value for the owner of the real estate.

In sum, the solution adopted by the Claimant for the purpose of accounting treatment of the facts that occurred in relation to B is perfectly acceptable. Indeed, the same is in consonance with an opinion sanctioned by the Legal Substitute of the Director-General of Taxes on 21-12-2006, whose conclusions are reproduced in paragraph m) of the findings of fact fixed, precisely regarding entrance rights in shopping centres.

By the foregoing, the accounting treatment adopted by the Claimant is, for fiscal purposes, that which is in harmony with the applicable accounting principles and, for this reason, should be considered legally imposed, in light of the rule of the determination of taxable profit based on accounting (with the corrections imposed by CIRC) which is established in article 17th, item 1, of the same Code.

Consequently, there was no legal obstacle to the Claimant considering as expenses of the year 2009 the proportional part of the sum spent on the works.

For this reason, the correction made and the act of assessment on which it is based are illegal, suffering from the defect of violation of law, by error as to the legal presuppositions (articles 18th and 23rd of CIRC) which justifies its annulment, under the terms of article 135th of the Code of Administrative Procedure, subsidiarily applicable under the terms of paragraph d) of article 2nd of the General Tax Law.

1. Decision

In these terms, agree this Arbitral Court in:

a) To judge the request for arbitral pronouncement well-founded;

b) To annul the additional IRC assessment and compensatory interest no. 2013 8310003259, relating to the year 2009, dated 15-07-2013, in the amount of €62,540.00.

1. Value of the Proceedings

In accordance with the provision in art. 315th, item 2, of CPC and 97th-A, item 1, paragraph a), of CPPT and 3rd, item 2, of the Regulation of Costs in Tax Arbitration Proceedings, the value of the proceedings is fixed at €62,540.00.

1. Costs

In accordance with art. 22nd, item 4, of RJAT, the amount of costs is fixed at €2,448.00, in accordance with Table I attached to the Regulation of Costs in Tax Arbitration Proceedings, to be borne by the Tax and Customs Authority.

Register it.

Lisbon, June 20, 2014

The Arbitrators

(Jorge Manuel Lopes de Sousa)

(José Alberto Pinheiro Pinto)

(Miguel Patrício)

Text prepared by computer, in accordance with item 5 of article 131st of CPC, applicable by remission of paragraph e) of item 1 of article 29th of Decree-Law no. 10/2011, of 20/01.

The drafting of this decision is governed by old orthography.

[1] Only supplemented with the consequences of the annulment decision at the level of assignment of compensatory interest and compensation for undue provision of guarantee, if applicable.

[2] Essentially in this sense, the following decisions of the Supreme Administrative Court can be seen, with respect to a parallel situation that arises in contentious appeal proceedings:

– of 10-11-98, by the Plenary, delivered in appeal no. 32702, published in AP-DR of 12-4-2001, page 1207;

– of 19-06-2002, case no. 47787, published in AP-DR of 10-2-2004, page 4289;

– of 09-10-2002, case no. 600/02;

– of 12-03-2003, case no. 1661/02.

In the same sense, can be seen:

– MARCELLO CAETANO, Manual of Administrative Law, volume I, 10th edition, page 479 where it states that it is «irrelevant that the Administration comes, already in the course of contentious proceedings, to invoke as determining reasons other reasons, not exposed in the act», and volume II, 9th edition, page 1329, in which he writes that «the responding authority cannot (...), in the reply to the appeal, justify the practice of the challenged act by reasons different from those contained in its express reasoning»;

– MÁRIO ESTEVES DE OLIVEIRA, Administrative Law, Volume I, page 472, where he writes that «the reasons objectively existing but not expressly adduced, as grounds of the act, cannot be taken into account in the assessment of its legality».

[3] MANUEL H. DE FREITAS PEREIRA, Relations between taxation and accounting, in Studies in Memory of Professor Doutor Saldanha Sanches, volume IV, page 953.